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DUTCH AUCTION

Typically, when people think of an auction, they think of either a numbers of bidders all competing and raising the price until one person wins and ends up paying the highest bid. The reality is that this is just one type of auction. For example, there are second price auctions in which the bids are sealed from all of the bidders and the winner actually pays the highest losing price. Dutch auctions are another variation on what is considered a traditional auction. These Dutch auctions are so-named because they have been used for centuries in Holland as ways for produce and flower vendors to sell their goods. In more recent times, sellers of fish, credit, and a wide variety of other items have used this auction version to sell their products.

In a Dutch auction, a seller offers up an item for bid at a very high price. The initial price is much higher than the item's value usually and no seller expects to get that price for the item. Because bidders must know the amount of the bids, bids are not sealed as they are in some types of auctions. The price is lowered in increments until a bidder chooses to accept the current price. He pays that price for the item as the winner. For example, if a business is auctioning off a used company car, the bidding may start at $15,000. The bidders will wait as the price is lowered to $14,000 to $13,000 to $12,000 to $11,000 and to $10,000. When the bidding reaches $10,000, Bidder A decided to accept that price and he because he is the first bidder to do so, he is considered the winner and has to pay $10,000 for the automobile.

Like second price auctions, Dutch auctions can also be used quite easily for selling multiples of the same item. For instance, if the business was selling three cars, Bidder A may have purchased the first at $10,000 but that wouldn't stop the auction. The price would continue to decrease. So it might go down to $9,000 then to $8,000 and Bidder B might choose to accept that price, so he would pay $8,000 for his car. Since one car is still available, the price continues to be lowered. At this point, the bidders would begin to get anxious since only one car is left. Bidder C would wait until the price went down to $6,000 and then he would make his move and would end up paying $6,000 for the automobile.

While the above example may make it seem like the seller could be losing money in a Dutch auction, the reality is that they generally make more than they would with a more traditional ascending-price auction. With an ascending-price auction, the bidders do raise the price but rarely will they raise above the item's actual value. They have no reason to act fast because they know exactly when the auction will end, and they can always sneak in at the last second with a slightly higher bid. In a Dutch auction, however, bidders must act fast because they have no idea when the auction may be over. So even though the price is being lowered instead of increased, bidders will end up paying at or even above the item's value.

One of the only problems with Dutch auctions has nothing to do with the auction logic itself but with a common area of confusion. The financial world and some third-party auction sites use the term “Dutch auction” when they refer to second price auctions. In truth, there is a huge difference between the two types of auctions. Second-price auctions are auctions in which the winners pays either the price of the lowest winning bidder or the price of the highest losing bidder. The confusion in the terms can be problematic for individuals interested in getting involved in either type of auction, so it is important to clarify which type of logic will be used before participating.

Depending on what individuals have to sell and how much money they hope to earn as a result of a successful auction, Dutch auctions can be an ideal alternative to more traditionally used approaches. The descending-price structure of these auctions increases competition among bidders and makes acting fast a necessity. Bidders just need to be sure that they are participating in a real Dutch auction, not a misnamed second price auction before getting started.